Advantages and Disadvantages of Debentures
The advantagess of raising funds through debentures are given as follows:
- Issue of debenture does not result in dilution of interest of equity shareholders as they do not have right either to vote or take part in the management of the company;
- It is preferred by investors who want fixed income at lesser risk;
- Interest on debenture is a tax deductible expenditure and thus it saves income tax.
- Debentures are fixed charge funds and do not participate in profits of the company;
- Cost of debenture is relatively lower than preference shares and equity shares.
- The issue of debentures is suitable in the situation when the sales and earnings are relatively stable;
- As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management;
- Issue of debentures is advantageous during times of inflation.
- Financing through debentures is less costly as compared to cost of preference or equity capital as the interest payment on debentures is tax deductible.
Debentures as source of funds has certain disadvantages. These are given as follows:
- Payment of interest on debenture is obligatory and hence it becomes burden if the company incurs loss.
- As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a greater risk when earnings of the company fluctuate;
- In case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty;
- Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company.
- Each company has certain borrowing capacity. With the issue of debentures, the capacity of a company to further borrow funds reduces.
- During depression, the profit of the company goes on declining and it becomes difficult for the company to pay interest.